VCs may be facing their toughest fundraising environment in years, but one kind of fund is bucking the trend.
Venture capital trusts (VCTs) — which invest retail investor money into startups — in the UK have continued to attract capital, as savers look to invest cash in fast-growing companies and reap the tax benefits.
This month, a number of the UK’s biggest VCTs have also launched new fundraises. The largest of Octopus Investments four VCTs — Titan — launched a new £200m fundraise last week, inviting retail investors with £3k-200k to spare to take a bet on its fund. Molten Ventures’ VCT, which often invests alongside its main fund, launched a new £40m fundraise at the beginning of the month for investors with the same amount of cash.
A total of £1.08bn was raised by VCTs from shareholders in the year to April 30, a 4% decrease on the previous year, according to the Venture Capital Trust Association. This contrasts with a 50% decrease in the funds raised by ordinary VC firms from their LPs in the first nine months of 2023, compared to 2022, according to PitchBook data.
“Our retail investors tend to invest with us for a long time as the tax incentive becomes very attractive over the long term,” says Will Fraser-Allen, chair of the VCTA and managing partner of VCT operator the Albion Capital Group.
“This means we have a very stable investor base that looks through the noise of individual years,” he adds.
VCT investment includes a 30% upfront income tax relief, as well as exemptions from tax on dividends and capital gains. But an investor can only qualify for these reliefs if they hold onto their VCT shares for a minimum of five years.
In the UK, several local VC firms have VCT funds in addition to their other more standard VC funds — including Albion, Molten Ventures and Octopus Investments. The latter is the biggest beast in the industry, holding almost £1.5bn in total assets as of 18 October, according to Association of Investment Companies data.
It has backed more than 140 companies through its biggest VCT fund, the £1.1bn Titan, including some of the UK’s biggest tech success stories — including Depop, Zoopla and ManyPets. According to its latest results, 18% of its portfolio saw revenues grow by 100% or more last year — which far outruns those of main market-listed companies.
Since 2017, when the VCTA began tracking the data, the yearly amount invested into VCTs has more than doubled. It is worth noting that the VCT industry still dwarfs in comparison to the VC industry in the UK: the amount VCTs deployed in 2022 is roughly a twentieth of the £22.7bn that VCs poured into UK startups last year.
More stable investors and capital allocators
Where European VCs may be struggling to convince their LPs to reinvest in the current tech downturn, the VCT investor’s profile means they’re more shielded from shorter-term events.
If the corporates or family offices that have newly invested as LPs in recent years don’t get returns coming out in seven or eight year cycles, then they can’t reinvest their money, says William Horlick, head of VCT at Molten Ventures.
On the other hand, the consistent tax reliefs for retail investors into VCTs has been steadily driving their investments even during the 2022 funding slump.
“As long as the economy is growing and people are generating wealth, then there’s always going to be the tax breaks — so it’s got a different cycle to it,” Horlick says.
“There aren’t many places where you can get a yield and the chance of capital gain.”
VCTs, their investors say, may even be more dependable sources of funding than standard VC funds. While they do have a three-year window to deploy capital once it has been raised from investors, they are constantly fundraising, which opens them up to capital allocation ‘top ups’ for their portfolio companies indefinitely. Fraser-Allen says that roughly 60% of Albion’s VCT investments were new and 40% were follow-ons last year, for example.
“We’re very comfortable having a longer hold period than perhaps some LP-backed VCs might have, which means we can support companies through multiple rounds of funding,” Fraser-Allen says. “So when we’re talking to founders, a useful way to think about VCTs as potential cap table investors is as a long-term source of stable capital.”
As capital availability dries up elsewhere, this is something that could appeal to founders even more than normal.
“I suspect this relative strength of VCTs will stand out even more in the next year or so, as we can continue to support our companies where others are having to say no,” Horlick says.
Notable recent bets from the UK’s biggest VCTs include Octopus Titan VCT’s investment in AI startup TitanML’s $2.8m pre-seed round at the beginning of the month; Albion VCT’s investments in lending fintech Kennek’s $12.5m Series A this month and quantum startup Phasecraft’s £13m Series A in August; and Molten VCT’s leading investment in mental health platform Oliva’s €5m seed round in June.
Potential headwinds
Where capital raised by VCTs only decreased slightly up to April this year, it’s not completely immune to broader headwinds.
Firstly, owing to their listed status, VCTs have to publish publicly-available investor reports. These reports include portfolio updates, in which VCTs provide their valuation estimations — a resource that’s been very useful for benchmarking where private startup valuations may be marked to market in recent months.
In Molten Ventures’ annual report in June, for example, the firm’s VC arm marked down the value of its stake in Revolut by 40%.
The VCTs themselves have also been linked to some high profile failures. Although the Octopus Titan fund has delivered £370m to investors through 26 successful exits, its former top performer is Cazoo — the used car startup that has seen its share price collapse 99% since IPO.
Repeated markdowns like this could make retail investors more nervous about re-investing in the risky asset class.
Second, after the UK government introduced changes to pensions allowances in March this year, VCTs are no longer the only place that retail investors can reap significant tax reliefs.
That’s because the cap on the tax-free allowance on annual pension contributions was increased from £40k to £60k, and the cap of £1.1m on lifetime contributions was removed. This means that many retail investors are now able to build a much bigger retirement pot than before without investing.
But the wealthiest individual investors (with an adjusted income of more than £260k) have had the ‘taper’ on their allowance only mildly increased from £4,000 to £10k — meaning that for them, the motivations behind investing in VCTs are still relatively attractive.
“If you look at the higher end investor that’s got a full pension pot, the VCT as a product is still well-placed to provide them with tax-free income and capital gains going forward,” Horlick says.
